December 05, 2008

FXIS Market Insights: December 5, 2008

Dear Friends & Fellow Investors

Good news first - Bright spots in bleak times
U.S. crude oil fell $2.86 and closed at just above $40 per barrel, the lowest settlement since late 2004. London Oil markets (Brent Crude Oil) settled even lower at $39.74/barrel earlier in the day. While the continued fall in commodity prices raises big concerns among most economists ("D" for deflation), I tend to view this as a positive sign. There is obviously a floor to the fall in oil and other commodity prices; producers will not sell below their production costs. Unlike individual stocks, commodity prices cannot fall to zero, certainly not commodities of limited supply. More importantly and as we pointed out a few weeks ago, for every one penny decrease in gasoline prices, U.S. consumers could save between $1.42 billion and $1.71 billion annually. reports an US average gasoline price of $1.75 per gallon, less than half of what it was this summer. We're looking at US consumer savings of several hundred billion Dollars annually if prices were to remain at these current levels.

The Australian way to deal with the global financial crisis
The Financial Times reports that "Australia tells 11m workers to take a break" -
This strategy is not without peril but it may work for less indebted societies. When you think about it, if you want the economy to get a boost from consumer spending, give people more incentives to spend.

Being on vacation is probably a more relaxed environment to entice spending. This too may work in countries with high savings rates particularly in Western Europe where people are generally more "tight" with their cash. Tell them to do it the Australian way, go on vacation and spend. US consumers however, are probably getting the end of the stick; no extra vacation days and/or not much cash left. The US needs to find other strategies to get out of the slump.

Another good explanation of the cause of the financial mess
Marketplace Senior Editor Paddy Hirsch gives a great explanation of the CDOs (collateralized debt obligations) those financial instruments that got us into this financial mess.

US Markets
The US markets came back from the Thanksgiving week-end to find a sort of "morning-after" surprise courtesy of the National Bureau of Economic Research - Thank you very much...

The ever-so genuine institution charged with determining the onset of a recession (as well as its end) said on Monday, that "the current downturn met its definition of a recession", exactly one year after the fact. The NBER of course did not say how long the recession might last, but that the stock market reflected pessimism. To add to such profound wisdom, the U.S. manufacturing activity fell to its lowest level in 26 years and eventually sending the Dow Jones Industrial Average down by 679 points - 7.7% for the day. As of today, we're still trying to recover from that one day downturn with the Dow still down over 2% for the week. This week too, the daily price movements between High & Low exceeded 5% intraday, Tuesday being the only day slightly below 5% (4.92%). Market volatility remains sky high at about 60% (more on risk and volatility below).

And let's not forget, employment numbers were atrocious this morning. U.S. employers axed 533,000 jobs from non-farm payrolls in November, the worst since 1974. With an unemployment rate of 6.7% the now officially year-old recession reflects an economy screaming for additional perhaps more dramatic government action to restore growth. And yet, the US markets had a late rally ending the day up over 3% (Dow) and 3.65% (S&P 500). Presumably, bad news was already priced in from the weekly jobless claims numbers and as is often the case, the market discounts bad news before the fact and reverses its course when the news is actually out. But with continued volatility at these levels and further bleak news that may not have translated yet into companies earnings, it is wise to stay defensive. As one trader recently put it: "Stay small and be fast, or stay out of the market". Particularly when possible deflationary scenarios are looming, cash still remains king.

Looking at market risk
We've all heard it before, diversification in these volatile times can substantially limit overall portfolio losses. We previously talked about a very simple aged based approach to investing wherein the bond/fixed income component of your portfolio should reflect your age. In short, if you are 50 years old, 50% of your portfolio should be in "safe" and income producing investments i.e. Bonds, CDs etc.

For a slightly more sophisticated look at risk management, the NASDAQ website has a wonderful and easy-to-understand explanation of volatility and risk. Click on the tab: Online Education to go through an entire short course on risk management.

Although you may or may not agree with the mathematical explanation of how these risk metrics rate certain stocks or other asset classes, the visual presentations of certain individual stocks compared with general market risk are an eye-opener, even for seasoned investors. Take for instance the riskmetrics ratings of Citigroup compared the Financial Sector ETF and also with the general market.

Everyone knows that the financial sector has been hammered and companies like Citigroup have had a horrendous fall from grace this year. Investing in individual stocks is risky - a lot more risky when compared with the already risky general market index. One simple way to spread your risk is to invest in the entire sector, by way of purchasing a cost-effective exchange traded fund (ETF), for instance the XLF (Financial Sector ETF). In doing so, you essentially cut your risk in half. (Important Note: this is not a suggestion to go out and buy financial stocks or financial sector ETFs. You're simply spreading the risk from one to many stocks in a cost-effective way. You still need to do your own analysis at to whether and when a specific industry or sector is considered a good investment).

Similarly, you can spread overall market risk with the inclusion of international stocks and possibly commodities and currencies (again when the time is right). Take a foreign currency like the Euro versus US$. This is now available as an ETF (ticker symbol: FXE). Although the Euro dropped about 20% from it's high point earlier this year, overall you'll be surprised to learn the currency trade was about 1/3 as risky as investing in the general US market this year.

Again, this is not a suggestion to go out and buy Euros or other currencies at this very moment. However, it illustrates the fact that a slightly more sophisticated approach to diversification should include an international component as well as other asset classes besides US equities. It is also important to note that there are various options to diversify internationally without the need to trade futures or options. You can do all this within your general US brokerage account these days. Many of these are available as ETFs and you can also invest in entire country indices if you're so inclined. Be sure to always read the disclosures and remember the general investing rule: Know what you're buying! In practice, if you buy a mutual fund or an ETF, you should know what the general investing strategy entails and you should definitely know what companies or other indices make up the core holdings of the ETF.

I would recommend that you try this site to evaluate your own stock portfolio against the general market and perhaps use some of the tools explained in the online tutorial to get a sense of how diversified and how risk balanced your portfolio currently is. If you need some input or help, please email

On Currencies
Currency markets were relatively benign this week. The Japanese Yen was probably the brightest of the dimly light currency stars this week both against the US$ as well as the Euro. Long-term charts suggest that a possible re-test of the recent low at 90.92 could ensue again. The Japanese Yen trade has essentially been a reflection of the strength or weakness of the global financial markets. As the crisis gains in strength, so does the Japanese Yen, above all other currencies these days. As long as global deflationary scenarios persist, the Japanese currency will continue to be strong, despite its continued low deposit rates.

It is also important to note that the European Central Bank cut rates by 0.75% and the Bank of England cut rates by 1% to an historic low rate of 2%.

Deposit Rates for major currencies are as follows: NZD 5.00%, AUD 4.25%, EUR 2.50%, CAD 2.25%, GBP 2.00%, USD 1.00%, CHF 1.00%, JPY 0.30%.
Good luck and good trading!


Neither the information nor any opinion contained in this email constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this email be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance.


Anonymous said...

Thanks for sharing. With deposit rates approaching near zero in most major countries, Japanese Yen may actually continue to be strong.

Tony Esten said...

Can you recommend some charts to view currency movements?